The Fight Over This Biotech's Cash

Elan was nice enough to give us a little more detail on what it plans to do with the $3.25 million that the biotech stands to get from Biogen Idec in exchange for turning over its rights to multiple sclerosis drug Tysabri and accepting a royalty on sales of the drug.

But just a little bit.

On Friday, Elan said it'll split the money between "strategic initiatives" -- essentially buying assets or drugs to help the company diversify -- and a $1 billion share repurchase. Elan failed to describe either program in enough detail to give investors much confidence.

Royalty Pharma has another idea: put the cash in its pocket after it buys the biotech. The investment management company purchases royalties at a discount providing upfront cash in exchange for long-term cash flow. Royalty Pharma has offered $6.6 billion -- $11 per share -- for Elan. The biotech acknowledged the offer and said it's considering it. From the tone of the press release, noting the "highly opportunistic timing" of Royalty Pharma's announcement for example, I would be surprised if Elan recommended that shareholders tender their shares to Royalty Pharma.

With the $3.25 billion from Biogen and another $600 million in cash and short-term investments on the books at the end of December, Royalty Pharma would only need to shell out about $2.75 billion to buy Elan.

Elan has $600 million in debt as of the end of December. Royalty Pharma would have to factor that in to the valuation. If Elan stays independent, it doesn't sound like the biotech plans to use its new cash to pay off the debt, but the stronger cash position should -- in theory, at least -- allow Elan to refinance the debt into better terms. Whether creditors think the company is really less risky remains to be seen.

What should investors do? I would guess that there's room for Royalty Pharma to increase its bid. Unsolicited bids are far more likely to be lowball offers than those of the take-it-or-leave-it variety. Whether Royalty Pharma is willing to increase it to a level that Elan's management is willing to accept is anyone's guess.

I'm not excited about holding Elan as a separate company. Sure, the royalties on Tysabri should be fairly solid, which is why Royalty Pharma wants the rights to the cash flow. Tysabri will face some competition from Biogen's new oral drug Tecfidera, which should be approved shortly, but Tysabri will likely fare better than multiple sclerosis drugs such as Novartis' Gilenya and Teva Pharmaceuticals' Copaxone. Tecfidera will likely be a first-line treatment like Gilenya and Copaxone, while Tysabri is typically used later due to the higher risks.

If you're going to own Elan, you have to trust management to make good choices with the cash, a track record that management doesn't have.

Rather than a share buyback, investors would be better off with a $1 billion dividend; that would be a hefty once-time 15% payment. Or better yet, return all the cash and become a shell company that distributes the Tysabri royalties as dividends like PDL Biopharma.

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